July 1, 2007
By: Richard W. Laubenstein
Shakespeare once said “neither a borrower nor a lender be.” Shakespeare obviously didn’t have a large family. If you have been able to build up a nice nest egg, you may soon find siblings, children or other members of your family and friends asking you to help them out.
Before you lend a helping hand, consider that almost 14% of personal loans (those made by individuals to family or friends) end up in default. That’s almost ten times the national average of defaults on bank loans. The main reason for the difference? Bankers aren’t afraid to ask questions before they decide to make a loan.
You are about to assume a big risk. Before you do, you have a right to know how your money is going to be used. If you are helping your family member or friend with a loan for their business, ask how much of their own money is being put at risk. Are there any other lenders? Can your loan be secured by equipment, stock, vehicles or real estate?
Your family member or friend may have a history of getting in debt over his or her head. If your borrower wants you to give them money that will be used to pay off other debt, you should ask how the borrower intends to change his or her spending habits. If your borrower continues in his or her cycle of debt, you could well find yourself in the position of having loaned and lost money that you were counting on for your future. You should not make a loan to family or friends unless you can afford to put your money at risk.
If you decide to make a private loan, make sure that the loan is well documented. Documenting the loan helps increase the likelihood of repayment. Borrowers take the loan (and the corresponding obligation to repay it) more seriously if it is in writing. In Illinois, interest rates are limited unless the agreement is placed in writing. If you have to sue to try to collect, you cannot collect your attorneys fees and costs unless the agreement is in writing. Our firm can help you prepare a note, repayment schedule and documents to secure your loan.
Documenting your private loans will help keep your own financial records straight. For example, if you have several children and you have advanced a loan to one of your children, having that loan documented will help keep the peace between your family members in the event you die, so that the various rights and claims to your estate can be determined.
In practical terms, if you have been blessed with the good fortune of having money socked away, you may be unable to turn down a family member in need. If you make a loan that winds up being uncollectible, and you have documented the loan, you may be able to write it off your taxes as a bad debt. If you can afford it, and you feel the money is going for a good cause, you may consider making the advance of money a gift from the beginning, instead of calling it a loan. We can help you document the gift for federal tax purposes. We can also help you maximize the amount of money available to you by assisting you with tax advice. Whether you make a loan or a gift, you should give us a call to help you document your transaction. Our October newsletter will discuss gifting proceeds from the sale of your assets.